The Construction of a Contractor Markup

Markup is the sum contractors must add to the hard cost of a job to cover both overhead and profit. Most contractors merely guess the time and cost of labor when pricing a job and, as a result, must also estimate the markup necessary to turn a sufficient profit and stay in business. How do contractors calculate the proper markup for every job to make sure their company remains successful?

Know the parameters

The cost of doing business, or the way a company determines expenses unrelated to actual construction, dictates how much contractors should mark up their price for a job. These expenses include the salary and benefits for offsite staff; rates for any design, engineering, or legal consultation; expenditures for marketing and advertising; and fees associated with permits, licenses and insurance.

“Figuring out what your markup should be is a simple mathematical formula,” says Shawn McCadden, a remodeling consultant and founder of Remodel My Business in Brookline, New Hampshire. “Unfortunately, about 80 percent of contractors have no idea what it costs to be in business.”

A company financial system that readily identifies expenses as direct or indirect (overhead) and separates them into job accounts enables a contractor to track as well as predict business performance. This study of past work often educates a company by forcing contractors to examine how they estimate jobs.

“History should be a guide in terms of anticipating how much things will cost for the next year,” McCadden says. “If you do business in a similar way, then you should have similar costs; if you’re going to change how you do business, then last year’s numbers can be used as a reference.”

Form a calculation

The method used for computing markup depends on how a company distinguishes the costs for each job. If a contractor elects to include workers’ compensation for a job in the overhead, for example, as opposed to a direct cost of labor, the markup required to cover both overhead and profit will be higher than a contractor who decides to classify workers’ comp as a direct expense.

“Every company needs to determine its own markup percentage based on what they feel they need for a net profit,” says Tim Ellis, president of T.W. Ellis LLC in Forest Hill, Maryland. “In my opinion, markup should be added to all of your cost of sales.”

Applying a single markup to the total expense of a job, or the overall cost to the contractor, helps a company reconcile potential discrepancies across different kinds of expenditures. If a contractor administers a greater markup on labor than materials, for example, but starts selling jobs that call for additional supplies, the markup on materials might prove to be inadequate.

“If you use the same markup on everything, it’s really easy to calculate, and you don’t have to worry about selling more or less materials, labor or subcontracted work than you thought you did,” McCadden says.

Define the boundaries

Many homeowners request to see how much a company marks up the price for a job, but separating that amount from the total cost exposes a contractor to unnecessary scrutiny. Even if contractors explain the indirect expenses of running their business and the markup needed to earn a requisite profit, clients often leverage this opportunity as a way to strike a better deal.

“They always want money off for something that might cost less, but they don’t want to have to pay more when you underestimated something,” says McCadden, who advises contractors to provide a fixed lump-sum price without a breakdown and not allow homeowners to manipulate their numbers.

When clients insist on knowing a company’s markup, the contractor should characterize the difference in broader terms. “We don’t define the percent markup to the homeowner; we line-item cost each product, and they see each charge on a product invoice,” says Dave Brady, president of Oak Design & Construction, a remodeling company in Oak Park, Illinois. “If they ask about our markup, we explain that we charge at retail price or just below, and that markup covers the cost of product ordering, delivery and warranty.”

Perhaps the most effective means of communicating markup to clients focuses on a company’s net profit. This business concept transcends construction and relates to just about every other industry in which entrepreneurs must make money to stay competitive and remain operational.

“When homeowners ask you which markup you use, they have no idea how it’s used or how it’s calculated anyway, so what is the value or the purpose of telling them what your markup is?” says McCadden, who recommends disclosing net profit to persistent clients as a percentage — say 10 percent — to convey the point.

Understand the consequences

Contractors must always remember that an appropriate markup should account for a company’s overhead as well as profit. “If you lost money on the job, you misestimated the cost of the job, not the markup,” McCadden says. “If you don’t have enough money to pay your overhead, then you’re using the wrong markup.”

But relying on competitors when determining the correct markup for a job can be just as troublesome. “If you’re trying to figure out what to charge, and you’re comparing yourself to your competition, remember that you have a 1 out of 10 chance of copying a contractor who will still be in business someday,” McCadden says.